The Legal Case for Pass-Through SALT Parity

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The Legal Case for Pass-Through SALT Parity

Last week, Bloomberg published a report that got our attention.  Entitled, “IRS May Knock down New York, Connecticut SALT Workarounds,” the article says the IRS is “likely” to issue regulations that invalidate SALT workarounds.

The reference to New York didn’t surprise us.  It’s no secret the IRS is targeting the charitable workaround adopted by New York and other states – they already issued guidance last fall throwing sand in the gears of that one.  But the pass-through SALT parity bills passed by Connecticut and Wisconsin are entirely different, both legally and politically.

Why can C corporations deduct all their SALT while individual pass-through business owners are subject to a $10,000 cap on their SALT deductions?   It’s patently unfair and the reason the S Corporation Association and our Main Street Employers coalition has spent the last year pressing states to adopt a pass-through SALT parity bill to level the playing field.

So exactly what does the IRS have in mind for Connecticut and other states looking at adopting pass-through parity?  Bloomberg doesn’t say, but here’s what we do know:

  • The current treatment of SALT deductibility for pass-through businesses is unpopular and a source of uncertainty for businesses and states alike.
  • Treasury added “Guidance on applying the state and local deduction cap under §164(b)(6) to pass-through entities” to their priority list last November, suggesting that something is in the works.
  • Treasury and the IRS would have to issue guidance on this topic regardless of state activity. The uncertainty surrounding the application of the SALT cap to pass-through business would require clarifying guidance either way.
  • Whether this guidance might attempt to block companies from deducting their entity-level state taxes is entirely unclear, as is the legal basis for doing so.

As to the last point, S-Corp has long maintained that the new SALT policy for pass-through businesses can be summarized as:

  • SALT imposed and paid at the individual level is subject to the new cap; but
  • SALT imposed and paid at the entity level is deductible at the entity level and reduces the distributive share passed on to the owners.

A new memo released this week expands upon these points and details the legal foundation underpinning state efforts to restore SALT parity for their S corporations and partnerships.  As it summarizes:

State income taxes paid by S corporations and partnerships, limited liability companies and other entities treated as partnerships (collectively, “pass-through entities”) under 2017 Wisconsin Act 368 (“Wisconsin Act 368”) should not be subject to the new $10,000 state tax deduction limitation under section 164(b)(6) of the Internal Revenue Code of 1986, as amended (the “Code”). The Internal Revenue Service (the “Service”) has consistently held that income and other taxes imposed upon and paid by pass-through entities are simply subtracted in calculating nonseparately computed income at the entity level, and are not separately passed through or incorporated into the various provisions and calculations applicable to itemized deductions at the individual level, such as the standard deduction, alternative minimum tax and the Pease reduction. In discussing the final provisions of the Tax Cuts and Jobs Act, the Conference Committee Report explicitly reiterated and relied upon this principle in describing the scope of new section 164(b)(6) of the Code.

While the memo focuses on the new Wisconsin law, its analysis is relevant to Connecticut and other states as they move forward to restore SALT parity.  Bills modeled after the Wisconsin effort have been introduced in Arkansas and Oklahoma, with other states not far behind.

These initiatives make states a more attractive place to invest and create jobs, all without reducing state revenue.  It’s a win-win for the states and their employers. This new legal analysis explains the authority behind these initiatives, and it’s designed to help more states move forward and begin the process of restoring parity for Main Street Employers.

2019-03-14T16:58:06+00:00